Iron ore prices have been smoked recently, falling from above $90 a tonne earlier this year to just $60 at present.
Any number of reasons have been cited to explain the recent shellacking.
Bloated Chinese iron ore port inventories, currently sitting at the highest level on record, is one. Concerns about a recent pickup in market interest rates in China has been another. And then there’s the prospect of a slowdown in the Chinese property market following moves from regulators in several major cities to cool rapid price growth.
There are others, including prior weakness in Chinese steel prices, the end product iron ore is used for.
While many have pointed to these factors to explain recent weakness across iron ore markets, the National Australia Bank thinks there’s another reason why prices have fallen so sharply, and it’s something that has been seen before. Speculators in Chinese commodity futures are back after a brief hiatus.
“Open interest has climbed rapidly in recent months from around 1.5 million contracts in late February to 2.4 million in mid-May,” the bank’s commodity analysts, led by Riki Polygenis, wrote in a note released on Friday.
“This increase has coincided with a plunge in the futures price — down 44% at the time of writing, a larger fall than the spot price.
“That speculative pressure — rather than underlying fundamentals — appears to be driving prices at the present time and increases the risk of price volatility in the short term.”
The NAB suggests that record Chinese inventory levels are also weighing on prices, so it’s not entirely being driven by speculators.
This chart from the NAB shows that as open interest in Chinese iron ore futures has increased, prices have been falling, and fast.
“There was little to suggest speculative pressure drove the upward trend in prices between October 2016 and February 2017,” it says.
“Open interest on the Dalian exchange fell and trading volumes slowed over this period as prices started to climb, consistent with the view that preference for higher grade ores was the major price driver in this period.”
While others have downplayed the role of speculators in Chinese iron ore futures, few can argue that the moves seen recently have been wild — an outcome one would expect with heightened levels of speculation.
For instance, on Wednesday this week, the most actively traded September 2017 iron ore future on the Dalian Commodities Exchange plunged following the news that Moody’s had downgraded China’s sovereign credit rating by one notch to A1 from Aa3.
At one point the contract hit limit down, meaning that the only thing that prevented it from falling further was that market rules prevented it.
“The economic mood turned sour in China as Moody’s downgraded the country’s debt, helping send the futures into a sharp dive,” said analysts at The Steel Index in the wake of the sharp and sudden plunge. “The most active Dalian iron ore futures contract lost 6.94%.”
A 6.94% fall in just one session.
While enormous, it’s not all that uncommon in Chinese futures. Moves of such a scale, and in both directions, are now deemed by many to be the norm rather than the exception.
It certainly points to the prevalence of speculators and suggests the wild price action seen recently will be around for some time yet.